Should I Make Additional Payments On My Mortgage

Hi everybody. Welcome back to another episode of Building Your Wealth Bridge. I know we normally have a couple of team members on our podcast, but I am doing this episode solo for the second time. I did one about a year ago based on social security and this episode will have some echoes of that episode in that number one, this episode is built off of some client case studies that have popped up a certain topic that some younger clients have been asking me about the past year, as well as my own personal experience dealing with this topic and the topic in question really has to do with people that have filed for a mortgage for the first time and are trying to get some good planning done around questions like how much I should be putting down in terms of a down payment for my mortgage and really the main thing I've been discussing you know with my clients and then thinking about for myself is this idea of additional payments.

Should I be making any additional payments on my mortgage and look to pay off my mortgage sooner than the term of the loan actually is. The second echo where this is similar to the social security podcast is that this is more of an art than a science to begin I'm not a mortgage expert. You know, I'm a financial advisor that has experience in buying my first home last year, but just to give kind of my opinions on how I think you know people might want to approach this topic and some of the pros and cons to thinking about paying off your mortgage early or waiting until the full term of the loan to finally pay it off.

So what I put together was basically a collection of different spreadsheets and this spreadsheet was actually provided to me by gentleman by the name of Mike Del Prado who was really our mortgage specialist that helped guide us through the process of filing for our first mortgage and I remember he shared this spreadsheet with me when I was asking him questions about how much I should be putting down on my house. Should I be doing more? Should I be doing less? You know, what about this idea of additional payments?

How does that work? So it's been a very helpful resource for myself and for my clients. I basically put together just a hypothetical, you know, based off of a couple of client experiences and you know, came up with some numbers similar to theirs. So though these numbers are not based off of any actual case and certainly not my own. But you know, one thing I thought I'd start with you have mentioned you know, approaching this I think is is a little bit more of an art than a science and when I talked about social security, what I meant by that was I told people the biggest question mark was you know, you just don't know how long you're going to live and that's really a key component of figuring out when you're going to file for social security, whether it's earlier or later.

[clears throat]

And it's a massive question mark. As it pertains to this topic of paying off your mortgage early, I think the biggest question mark is what's the market going to do? And you know, if anybody is telling you they have a good sense of exactly what it's going to do year-over-year for the next 20 years, that I think they've got a bridge to sell you as well. So you know, I think the biggest question that comes up and the biggest debate around this topic starts with you know, what is the interest rate that you are paying on your mortgage.

Okay. And that's changed significantly over the last couple of years. I know of some clients that were able to refinance their mortgage prior to 2022 at what seemed like rock bottom rates of like two and a half two and three quarters percent. And now people are dealing with you know, just a year or two ago filing for new mortgages north of 6%. Those have come down somewhat.

[snorts]

But there's this big debate around at what point does it make more sense to either pay off your mortgage early or to take that money that could pay off the mortgage and simply invest it in the stock market, okay? And you've got people at both ends of the spectrum. I think, you know, Dave Ramsey's team is a good example of people that say, "If you've got all these goals of having an emergency fund, having, you know, savings account for your bigger expenses over a year or two, you're funding your retirement accounts." Their advice is pay that home off as soon as possible.

And you've got people at the other end of the spectrum saying that is just absolutely ridiculous, you know, the best thing you can do is invest your money for the long term and they really feel strongly that, you know, by taking an aggressive approach, the return you can get on your money in the stock market is going to be far above and beyond, you know, the interest you're paying on your mortgage. So, you know, just kind of the level set that and give you a sense of some things to think about.

Number one, you know, where we're at today is very different than where we were a couple of years ago. You know, paying a 5 and 1/2% mortgage rate is a lot more difficult to overcome than a 2 and 1/2% mortgage rate. I think another really important thing to think about when I talk to people about this issue is this idea of, "Okay, if it's a younger person, they say, well, if I invest that money you know, in 100% stocks over the long term, very confident that I can beat 5 and 1/2%." one thing I'll bring up to them is the idea of, "Well, where is that money going?

You know, is it going into a retirement account where it's tax deferred? Or are you taking that money and putting it into a taxable account?" Because one thing to take into account is taxes, right? So, particularly for people that are putting money into a taxable account, typically people will have to pay capital gains tax on money that they are putting into there, seeing gains on with the investments, and then ultimately selling it. So, if you can plan on, for most people, paying 15% capital gains tax, you want to factor that in when you're comparing the rate of return you're going to get versus the mortgage interest rate that you're paying, right? [clears throat] So, what it like on the face of it, you know, the example we use here is around you know, 5 and 1/2% interest rate.

You know, what's going to be your after-tax rate of return that you'll need to get to beat that or should I say, your pre-tax rate of return might have to be 6 and 1/2, right? In order to get an after-tax rate of return close to 5 and 1/2%. So, I think that's really important is taking into account the taxes when you're thinking about the actual gross percentage you're getting on your investments versus what you actually keep at the end of the day. Another thing that was really eye-opening to me when I went to file my first mortgage was thinking and I think this speaks to people that say, "Hey, it maybe it does make sense to take some money and invest it versus paying down your mortgage." Is this idea of how interest is actually paid on a mortgage loan?

I think on the face of it, you know, not being very knowledgeable in this area, I thought, you know, hey, on a 20-year loan you know, if I'm paying 5 and 1/2%, you know, and my you know, average payment, you know, if we look down here is it 2750 a month, you know, that the interest portion of that would be the exact same every month for 20 years. And that's just not the case. Much earlier on in the maturity of a loan, you're paying a lot more in interest.

So, like in that first month that you're making a payment of that 2750, like 18 over 1800 is interest. As you get much later on in the loan, you can see that these interest payments go down and down and down. And so, I think that's relevant, okay? When you think about

[clears throat] interest that you're paying on a mortgage versus investing it and seeing compounded growth is that over the long term, you know, 10-15 years from now, the actual interest that you're paying on the outstanding loan becomes less and less and less, okay?

Versus if you're investing that money, the compounded growth is a little bit more exponential if you continue to see good returns. So, it's not just a simple equation of you know, if my mortgage rate is 5 and 1/2% a year, you know, that's the after-tax rate of return I have to make in order to beat that because this, you know, game that gets played of the more the interest gets collected by the bank up front is relevant in, you know, considering your strategy around it, okay?

And I think that was one also one interesting thing to me when I was thinking about just mortgages in general and just the idea that, hey, they can fund help fund the purchase of this home that I am getting. And I have a long time to pay that back. Seems like a good deal for me. But this is where the banks win is that they collect a significant amount of the interest on that loan up front. So, one thing I loved about this spreadsheet, you know, that was sent over to me by my mortgage broker, is after I think it's 5 years, you know, you see in this scenario, there was around $101,000 of interest paid on a total interest of 260 over the life of the loan.

So, I think that that's 2/5 that's like 40% of the interest, you know, given this type of scenario where it's like, hey, my loan amount's $400,000, you know, 5 and 1/2% interest rate over 20 years, the bank gets 40% of the interest if I'm doing my math right on that based on these figures over the first 25% of the loan. So, [clears throat] they really get ahead of this issue by collecting their interest up front. So, by the time that you get to the end of the loan, you know, even if you decide to pay it off early later on, they've already collected a bulk of the interest that they were going to collect anyways.

And so, that is I think is how, you know, the bank quote-unquote wins. So, some of the questions I've gotten from clients over the last year or so, and I think this topic is particularly relevant to people that maybe filed for a mortgage, you know, in the last 5 years. And they're just doing a lot better financially than they predicted that they would. And they're just saying, "I've got a lot of, you know, loose cash laying around." And they're asking themselves, "Should I invest this or should I pay down my mortgage?

And, you know, what's going to be the difference, you know, based on which path I choose?" So, some of the things I wanted to run through that were eye-opening to me, was just starting with, you know, this idea of the down payment, okay? So, the example that I'm going to use here is essentially for all of these cases outside of the screen I'm currently on, will be a half a million dollar mortgage loan, 5 and 1/2% interest over 20 years, basically starting in May of '26, okay?

But I know something that will come up for people that are a little bit cash heavy may say, "Hey, I have the ability, to maybe put more down. Like, what if I have an extra 100,000 that I could put down on the loan?" One thing that I found interesting, in running these numbers, was let's say you have 100,000 extra dollars, you put it down on your home, you know, over the lifetime of that loan, if you don't make any additional payments, you just say, "Hey, I'm going to take that extra 100,000 and put it down as a down payment." But then I'm just going to make my payments over 20 years, the total interest over that period is around $260,000.

What was very eye-opening to me was just taking a look at, okay, let's say you don't Let's say you don't make that additional, you know, down payment as part of the loan that you open. So, you start off with half a million dollars, okay, in a loan of the same exact scenario, 5 and 1/2% interest over 20 years. But, let's say after 10 years, 10 years into the loan, you say, "You know what? Now I've got $100,000 extra, and I'm going to put that money down towards the loan to pay some of that off early." So, basically what we're comparing is you put $100,000 extra up front, okay, as part of the down payment, or you wait 10 years and then you put it down in the form of an additional payment.

The lifetime interest is very close. It's around $266,000. And I think the reason for that is because any additional payment that you make comes directly off of principal, which is a huge difference maker. So, basically the differences between these two scenarios is you know, by making a bigger down payment up front, okay, your monthly payment, you can see, is like 2750, I think, a month for 20 years. But, you don't make any additional payments. So, you're pay you're making payments for 20 full years, and you're paying the full interest over those 24 years, or I'm sorry, 20 full years, versus you know, if you put less down, your monthly payment is higher, you know, which is a the potential downside of that.

It's like 3450 a month, essentially. But, when you put 100,000 down after 10 years, it comes directly off of the principal. So, it basically means that you're paying off that loan sooner, which is really surprising to me that the total interest ended up being very similar because you pay off the loan so much sooner after paying 100,000 after 10 years. So, I think that was very eye-opening to me. You know, one thing that I looked at in speaking with some clients, you know, and kind of getting back to level setting, was just this idea of if you do additional payments, like there's a variety of different ways you could approach it.

And so, the question becomes like, what way should you approach it if you're somebody that says, you know, what, I know how now I know how the bank wins because they collect most of their interest up front. How do I beat the bank? So, if this scenario kind of level sets everything, let's say it was a half million dollar loan. You got 5.5% interest on that loan over 20 years, and starts in May. Essentially, without making any additional payments, okay, the total interest over the life of that loan might be $325,000 over a 20-year period, okay?

So, let's say somebody said, "Listen, I do want to make some additional payments, but like is that really going to make a difference over the long term?" And so, I've recently talked with a client where we basically took a number, and we said, "Okay, what if we had $100,000 to make in additional payments? How can we structure this? What would the difference be between, you know, let's say we took $100,000 and made an additional payment now? What would it look like if we did it, you know, 10 years into the loan?

What would it look like if we just did a small monthly amount every single month for the course of, you know, 7 years? And what if we did kind of a mix and match where we did like a decent chunk up front, and then we did smaller chunks like every 6 months? So, you know, kind of using this baseline, half million dollar loan, 5.5% interest, 20-year loan, the total interest was around $325,000. One thing that I thought was interesting, you know, looking at and we kind of ran through this already, which is, okay, what if we waited 10 years, you know, and really your career takes off, and then you have a lot of cash on hand down the line?

How much of a cost saving is that really? And it's not insignificant, right? You go from a $325,000 total interest to around 266 all in by just making one big lump sum additional payment, you know, 10 years into the loan, okay? What I thought was, you know, a good follow-up to that was like, okay, well, what if we did that in smaller pieces, you know, over like the first 7 years of the loan. So, what if, you know, we did $1,200 in additional payments every single month for the first 7 years, which would basically be like 100 grand after 7 years.

That was really eye-opening to me again, using all the same variables, but just changing the fact that instead of waiting 10 years and doing a big lump sum by just doing 1,200 a month, the total interest, you know, we started at 325, then we got to 266 by doing that lump sum after 10 years. Now, doing it just a small monthly thing, you drop all the way to 209. So, you went from 325 to 209 just by making a small monthly payment every single month. Once we had discussed that, you know, and I think these next two scenarios are particularly relevant to like I said, people that just are cash heavy right now.

Maybe they put down a smaller down payment. And maybe they thought they had another big purchase coming up or some expenses that didn't come through and now they've got extra cash. And they think you know, what's the best way to maybe put some of this towards our mortgage and pay it off early, was this idea of what if we took, you know, of that 100,000 that we have, what if we put 50 towards it up front? And then we paid, you know, $10,000 every 6 months for the next 2 and 1/2 years.

And so, that one came out to around, you know, $182,000. So, again, we started at 325 and then with scenario two, we're 266 and then with you know, $1,200 a month, we're 209. You know, by putting 50,000 up front and then 10,000 every 6 months, now you're at 182. So, I think you can see the trend here, which is essentially that if you want to beat the bank, making additional payments as early on in the loan period as you can is going to be more beneficial to you.

And that's kind of the deal the last scenario here which you know, may seem like it's not applicable to a lot of people, but it could be for high earners or people that are cash heavy. Just this idea of hey, you know, even going back to this idea of hey, if I took, you know, put 100,000 towards the down payment will pay it over 20 years versus if I started out with a half million dollar loan versus 400,000 and then immediately made 100,000 dollar additional payment.

You can see that the total interest goes down to 173. So, I guess at the end of the day what I'm getting at least for me, was that this was extremely eye-opening about how the numbers change as you strategize around this. And frankly, when I was talking to my client about these different options, we found that there's probably a middle ground, right? If you think about the prospect of putting 100 grand down like immediately into the maturity of the loan, it drops you down to, you know, the most the 173, but if you compare that to, you know, these other two scenarios where hey, putting 1,200 dollars a month for 7 years, you know, 173 versus 209, it's 36,000 dollars.

It's not nothing, but it's you know, not strikingly different when you think about how you're able to space out those payments over 7 years versus putting a huge chunk up front. And also, I think for the client I talked to, like the main sweet spot was like, well, what if we put like 30 or 50,000 up front, and then we kind of take smaller chunks, whether it's like 8 or 10,000 dollars every 6 months until we get to that 100,000 dollar level. That might strike a really good balance between, you know, making sure that you are minimizing the total amount of interest and that you are paying on your mortgage.

At the same time, you're giving yourself some breathing room as it relates to your cash flow, right? And so, that was really it in a nutshell. So, you know, like I said, this is more of an art than a science. I know there's some people out there that would say, "Hey, you know, some of the biggest negatives that I didn't cover would be that hey, once this money gets put towards your mortgage, you know, it's tied up in your house, right? And so, basically, you are banking on the appreciation of the home that you have.

If you look at it from an investment standpoint, that's basically, you know, the growth that you're going to see is just based on how the value of your home grows. Some people will also say, "You know what, tying up money in your home, it becomes a lot less liquid than your investments, right?" So, that's something else that I think you need to consider is having money tied up in your home, you know, makes it a little less accessible. You know, there are strategies like opening up a HELOC and being able to, you know, access some cash flow, tapping into the equity in your home. But I think the one thing I would stand firm on is this idea that

[snorts] if you are going to make additional payments, make them as early on as in the loan as you can.

Because just going back to what we talked about with, you know, whatever your monthly amount is going to be, if you look at what the interest portion is early on in the loan versus what it is later in the loan, it can really you know, save you some hard dollars, I think. If you're somebody that says, "Well, I could afford to do, you know, 100,000 over a couple years, but why don't we just do 1,200 a month for 7 years? You know, I just like that consistent pace." If you know you're going to have that cash regardless, it's good to know how much more that costs you in hard dollars when you think about the interest, you know, over that few year period just for, you know, the sake of doing something consistently and in smaller chunks.

So, I hope this has been helpful to people. You know, I would love to hear from others in terms of what their strategies are surrounding mortgages, what items I may have missed, but I think this is kind of a fascinating topic and it's one that a lot of people deal with. So, for clients of ours, if you have any questions or like to use the spreadsheet as a resource, please reach out to our firm.

This transcript was generated from the episode audio and may contain errors.